ch. 4 - Chapter 4 Study Objectives After studying this...

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Financial Accounting - Chapter 4 1 Chapter 4 - Study Objectives After studying this chapter, you should be able to: 1. Explain the revenue recognition principle and the matching  principle. 1. Differentiate between the cash basis and the accrual basis of  accounting. 1. Explain why adjusting entries are needed and identify the  major types of adjusting entries. 1. Prepare adjusting entries for prepayments. 1. Prepare adjusting entries for accruals. 1. Describe the nature and purpose of the adjusted trial balance. 1. Explain the purpose of closing entries. 1. Describe the required steps in the accounting cycle. 
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Financial Accounting - Chapter 4 2 Revenue and the Recognition  Principle Revenue  is the price of goods sold and services  rendered during a given accounting period.  Revenue  alone is either an inflow of cash or the creation of a  receivable which increases total assets.  On the other  side, owners’ equity also increases. However, revenue must be recognized using the  revenue recognition principle  which states that  revenue is recognized when it is earned without  regard to when the payment is received. Revenue is considered earned when the service has  been provided or when the goods are delivered.   
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Financial Accounting - Chapter 4 3 Expenses and the Matching  Principle Expenses  are the cost of the goods and services used  up in the process of earning revenue.  Examples  included the cost of goods sold, salaries, advertising,  rent, and depreciation of many long-term assets.  All  of these costs are necessary to earn revenues.  In  addition, an expense always causes a decrease in  owners’ equity. In determining net income for a period, the  matching  principle  requires that the revenue earned should be  matched (offset) with the expenses incurred in the  same period.      
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Financial Accounting - Chapter 4 4 Accrual vs Cash Basis of  Accounting GAAP prefers accrual basis of accounting whenever  financial statements are used by investors and  creditors.  The two general rules of the accrual  basis of accounting are: Revenue is recognized when earned. Expenses are recognized when incurred. The two general rules of the cash basis of accounting  are: Revenue is recognized when cash is collected. Expenses are recognized when cash is disbursed.
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Financial Accounting - Chapter 4 5 Nature and Purpose of  Adjusting Entries The purpose of adjusting entries is to allocate revenue and  expenses among accounting periods in accordance with the  revenue recognition   and  matching  principles.   Because of the accrual basis of accounting, all revenue and 
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